1. Field of the Invention
The present invention generally relates to financial methods, systems, and computer program products for calculating a reduced fee associated with combining previously securitized mortgage-backed securities to form a new and larger security instrument that is backed by two or more of said previously securitized mortgage-backed securities.
2. Discussion of the Related Art
Many consumers who purchase a home will borrow funds from a lender and grant the lender a security interest in the home, which serves as collateral. The legal document whereby the consumer/borrower uses the property as collateral for repayment of the loan is commonly known as a mortgage. Lenders sell many of the mortgage loans that they originate in exchange for cash or securities into the secondary mortgage market that is dominated by the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and the Federal National Mortgage Association (“Fannie Mae”). By selling mortgage loans into the secondary mortgage market, lenders access capital in order to have funds to meet consumer demand for additional home mortgages. The secondary market for mortgage loans keeps the supply of money for housing widely available and ultimately lowers costs to consumers.
Freddie Mac and Fannie Mae will either purchase home mortgages for cash or issue securities in exchange for the mortgages. When securities are exchanged for mortgages, they are known as mortgage-backed securities (MBS). The Freddie Mac brand name for these securities is “participating certificates” and the Fannie Mae brand name for these securities is “pass-through certificates.” The generic term, MBS, is used herein to refer generically to these types of securities. MBS are pass-through securities that each represent an undivided beneficial interest in one or more pools of mortgage loans or in other MBS of pooled mortgage loans. In general, a mortgage pool is a positively identified group of mortgages combined for resale to individuals or entities called MBS “holders.” A MBS may consist of mortgage loans sourced from one or more lenders and organized into pools based on shared characteristics. For a fee, Freddie Mac and Fannie Mae will also analyze an issuer's inventory of mortgage loans to determine an optimum securities structure.
Although the Tax Reform Act of 1986 (“TRA 1986”) eliminated many of the tax advantages of traditional real estate ownership and syndication, it offset this in part by creating an innovative tax structure that changed the way real estate mortgages could be held. The TRA 1986 authorized the creation of the real estate mortgage investment conduit (“REMIC”) as a vehicle for creating multi-class, pass-through, MBS that resolved certain tax and balance sheet problems associated with another mortgage security called the “collateralized mortgage obligation” or CMO.
The REMIC is an investment-grade mortgage bond that separates mortgage pools into different maturity and risk classes and serves as a conduit for holding the mortgage pools represented by the MBS. Cash flows derived from payments of principal and interest on the underlying mortgages are passed through the REMIC structure to holders of each REMIC class with no income tax consequences to the REMIC structure itself. The process of forming the mortgage pools and issuing the MBS is called securitization. Most securities trading in the United States receive a CUSIP (Committee on Uniform Securities and Identification Procedures) number, which is a unique nine-character number that identifies the security. A CUSIP number is like a serial number; each individual security traded in the US market has a different CUSIP number that functions to uniquely identify that security.
A REMIC is a multiclass, mortgage-backed security in which cash flows from the underlying collateral (e.g., a pool of pass-through securities) are allocated to individual groups of bonds, called tranches, of varying maturities, coupons, and payment priorities. Each REMIC includes a set of two or more tranches, each having average lives and cash flow patterns designed to meet specific investment objectives. These tranches are distinguished by their sensitivity to the prepayment risk of the underlying mortgage-related collateral. Therefore, they may have different sensitivities to prepayment risk, bear different interest rates, and have different average lives and final maturities.
REMICs offer investment flexibility because each REMIC may be designed according to specific investor needs or general market demand. As such, an underwriter of the REMIC can provide the issuer of a REMIC with a proposed deal structure before the issuance of the REMIC. It is the responsibility of the issuer to take that structure and validate it for accuracy, e.g., that the cash flows are appropriately allocated across tranches and groups and that there is nothing about the structure that the issuer cannot accurately disclose. Additionally, the underwriter validates that the issuer should be able to settle any trades on a timely basis and accurately make monthly payments to investors after any bonds in a REMIC are sold.
Several years after the first REMICs were formed, Freddie Mac and Fannie Mae began to combine previously securitized MBS to form new and larger securities backed by two or more MBS. Freddie Mac refers to this security structure as a Giant MBS, and Fannie Mae refers to these as a Mega MBS. Ginnie Mae refers to these securities as Platinums. For convenience, the term “Mega” is used herein to refer to Platinum, Giant, and Mega MBS. Megas and Giants are pass-through securities formed by combining individual MBS (or portions of MBS) with other MBS (or portions of MBS). Megas and Giants allow investors to manage their portfolios efficiently by consolidating smaller MBS into Megas or Giants. (Investors in Megas and Giants are known as “holders.”)
For example, a holder with a portfolio of 100 smaller MBS, each a separate security, has to track and account for 100 different CUSIP numbers. If the holder has the 100 MBS combined into a single Mega or Giant, however, the holder has to track and account for only a single CUSIP number assigned to the Mega or Giant. Holding a Mega or Giant greatly reduces the internal processing and accounting costs for tracking the balance and monitoring the monthly payments associated with underlying mortgage investments compared to the cost of holding several smaller MBS that each pay on different schedules and may amortize at different speeds. Megas and Giants are large, highly liquid, and transparent, making them more attractive to investors than smaller MBS.
Other benefits of investing in Megas and Giants are: lower borrowing and security administration costs resulting in standardized pricing; increased market liquidity; ease of trade execution; the availability of customized pooling; and the fact that comprehensive disclosure of Megas and Giants are readily available to holders.
Megas and Giants lower internal processing and accounting costs because it is easier to track the balance and monitor the monthly payments for one large pool rather than multiple smaller pools. From the holder's point of view, it is more economical to receive periodic payments by wire from a single Mega or Giant pool than to receive multiple wires relating to the multiple underlying pools. From the administrator's point of view, the economies of scale result in lower administration and transaction costs for larger pools and therefore dealers and financial institutions are able to charge lower rates for administration.
Moreover, by forming Megas and Giants, issuers may combine odd sized MRS into one pool and achieve the more standardized pricing available for large pools, such as those with aggregate loan balances in excess of $5,000,000. Another feature that makes Megas and Giants more attractive to the market than smaller pools are that they are more likely to meet the Bond Market Association's (BMA's) “good delivery” guidelines. The good delivery guidelines require loans in the pool to have a minimum pool balance ($25,000) and a predefined range of maturity dates, depending on the securities. (By way of example, for 30-year Freddie Mac or Fannie Mae securities, the predefined range of maturity dates is between 181-361 months to maturity; for 15-year Freddie Mac or Fannie Mae securities, it must not exceed 181 months, and for Ginnie Mae 30-year securities, there must be 28 years remaining).
Megas and Giants also provide the ability to structure pools of loans having specific characteristics, such as loans with greater geographic diversity, or loans with a geographic concentration, or loans with a short weighted average remaining maturities (WARM). For example, a holder may realize that there is more value in a pool that is structured to reduce the prepayment variation (achieved through greater geographic diversity), or that there is value in a pool with a short WARM. MBS and Megas/Giants (or portions thereof) can be combined, in turn, and the cash flows from these MBS and Megas/Giants can be directed to REMIC class securities in a process called resecuritization.
Until recently, an internal business division of Freddie Mac was the single largest buyer of new-issue Freddie Mac securities from the mortgage banking community. It also ranked among the top national dealers in terms of monthly Mortgage-Backed Securities Clearing Corporation trading volume. Through this business division, known as the Securities Sale and Trading Group (“SS&TG”) SS&TG, Freddie Mac provided liquidity for mortgage-backed-securities and maintains a long-term market presence.
SS&TG's primary business was to function as a dealer in Freddie Mac securities (other than common stock). SS&TG's dealer functions included:                Buying and selling for its own account or the account of others, making a market in, and standing ready to buy and sell or lend on the security of any mortgage or interest therein (including any security representing such an interest) which Freddie Mac is authorized to purchase or lend against; and any other Freddie Mac security (other than common stock); and        Engaging in any direct, hedging, ancillary, customer accommodation, or other transaction, contract or activity which Freddie Mac is authorized to engage in, in support of the above dealer functions.        
SS&TG also functioned, from time to time, as an underwriter of Freddie Mac securities (other than common stock). SS&TG's underwriting functions included:                The acquisition of Freddie Mac PCs and other securities in cash auctions, syndicated public offerings and private placements directly or indirectly from Freddie Mac with a view to redistribution; and        Resecuritization transactions in which SS&TG acquired mortgage-related securities or other collateral from one or more counterparties, delivers such collateral to the Corporation in exchange for securities backed by, or representing an interest in, in whole or in part, the collateral delivered to the Corporation, and retains or resells such securities, or other similar structured financing transactions, including real estate mortgage investment conduits (REMICs), combined cash flow securities (CCS), funding note securities, swap trusts (other than currency-based swaps) entered into in connection with authorized underwritten securities transactions, or similar derivative-based structured securities offerings.        
SS&TG also functioned, from time to time, as a trader of mortgages or interests therein, mortgage-related or other securities, and other instruments or investments which the Corporation may purchase or sell (other than common stock). SS&TG's trading functions included the maintenance of inventories of mortgages, securities and other instruments.
SS&TG also performed, from time to time, other market-related functions and engaged in other market-related activities in support and furtherance of the above functions, such as advisory, custodial, information processing, marketing, and similar activities or services.
In these roles, SS&TG sought to convert various MBSs issued by Fannie Mae into one or more Megas. For example, the ARM (adjustable rate mortgage) trading desk of SS&TG submitted pools of Fannie Mae bonds to Fannie Mae to be grouped together into larger pools every month. These larger pools are the previously mentioned Megas. Fannie Mae charges a standard fee to form the Megas. However, Fannie Mae offers fee discounts depending on the number of Megas formed and the total amount of the Megas formed (i.e., giving a bulk discount). A group of Megas that qualify for fee bulk discounts is called a Mega-group.
For example, currently Fannie Mae charges a fee for reissuing debts in the form of Mega-groups based on the following percentages and sizes.
.0234375%$250 million.03125%$100 million.046875%  $75 million.0625% $50 million.078125%  $25 million
To qualify for the bulk discount fee, Mega-groups must be formed from 3 or fewer Megas. Thus, if an investor can group together three (3) Megas into a single package that forms a Mega-group, the investor can receive a discounted package level fee for formation of that group.
However, Fannie Mae does not automatically calculate or otherwise apply a reduced fee for bulk purchasers of Megas. It is up the purchaser of the Megas to group their purchases into Mega-groups and then identify each Mega-group as qualifying for a discounted fee.
The total number of possible Mega-groups is called a Bell number, which is the number of ways a set of n elements can be partitioned into non-empty sets. An expression for a Bell number is
      B    n    =            ∑              k        =        1            n        ⁢                  ⁢                  S        2            ⁡              (                  n          ,          k                )            where n is the total number of elements to be grouped, k is size of any particular group, and S2(n, k) is a Sterling number of the second kind, which is defined as follows
            S      2        ⁡          (              n        ,        k            )        =            1      /              k        !              ⁢                  ∑                                      ⁢                          ⁢                                    (                          -              1                        )                    i                ⁢                  (                                                    k                                                                    i                                              )                ⁢                                            (                              k                -                i                            )                        n                    .                    
Thus, if there are 12 Megas (i.e., n=12), there are 4,213,597 possible groupings of these 12 Megas (i.e., B12=4,213,597). However, these 4,213,597 possible groupings include groupings of all sizes, whereas for some fee structure calculations, the Megas may only be grouped in groups of m or less (e.g., m=3). Thus, the 4,213,597 sets of Mega-groups must be winnowed to exclude all Mega-groups larger than the predetermined size. Once this group is winnowed, the optimum set of Mega-groups must be selected from in such a fashion that fee is the lowest possible.
Current methods for packaging Megas into Mega-groups for fee calculation purposes is an intuitive, “eyeball” best-guess of the best combination of Megas that qualifies for a discounted fee. But as recognized by the inventor, this “eyeball” approach suffers from a lack of accuracy when large numbers of Megas are being obtained. This lack of accuracy translates to lost profits due to unnecessarily higher processing fees.
Also, while there is software relating to a variety of conventional combinatorial techniques, such as the ‘knapsack problem,’ that may be downloaded from the internet, these conventional techniques do not produce a complete set of all groups, where a set size may not exceed a predetermined limit. Thus, as recognized by the inventor, conventional techniques and corresponding software are not applicable to the problem of packaging Megas into Mega-groups for fee calculation, where the size Mega-group is restricted.